Chemical mergers and acquisitions activity poised to gain in 2011

01 March 2011 21:11  [Source: ICB]

Strategic buyers flush with cash and a strong financing market will drive activity to higher levels this year. DuPont and Clariant provide early firepower

With an environment conducive to deal-making, the global chemical mergers and acquisitions (M&A) market is poised to gain further in 2011 after a strong rebound in 2010.

"Unless there is another economic or financial crisis, we expect 2011 to be another active year for chemical industry M&A and will likely match or exceed 2010 levels - both in terms of number of deals and dollar volume," says Peter Young, president of US-based investment bank Young & Partners.

"This is being driven by the overall stability of the global economy, an increase in buyer confidence, the ready availability of debt financing and the need to begin using the cash stockpile that companies have amassed," he adds.

In 2010, $36bn (€26bn) in chemical deals were completed on an equity basis - up sharply from a trough of $25bn in 2009, according to Young & Partners.

Even more significantly, the number of completed deals above $25m in size jumped to 64 versus 26 in 2009.

Also, the backlog of announced deals yet to close rose to 26 deals worth $26bn at the end of 2010, compared with five deals worth $6.3bn at the end of 2009, notes Young.

The banker also expects the Asia and rest-of-the-world category to continue to lead as the most active M&A market, ahead of the US and Europe. In 2010, the former category accounted for 41% of all chemical deals versus 30% for the US and 29% for Europe.

"For many years, Asia and Middle East-based chemical companies had been more focused on new plants, joint ventures and building capacity. But now, as those businesses have reached a more mature state, they're in more of a position to buy and sell," he says.

PIPELINE TO FILL UP
More strategic and financial owners of chemical assets will consider sales in the coming months as valuations remain firm and the financing market improves.

"The pipeline of new projects continues to show modest improvement," says Chris Cerimele, director and head of chemicals at US-based investment bank Houlihan Lokey.

"The financing market is basically back to pre-bubble normalized levels of 2004-2005. The high yield market is strong and leverage levels are back," he adds.

For a solid mid-market chemical business with more than $10m in earnings before interest, tax, depreciation and amortization (EBITDA), buyers can borrow at a level of at least 3.5-4.0 times EBITDA to finance the deal - about 0.5-1.0 times better than a year ago, according to the banker.

"I never thought I'd see this much of a comeback so quickly in the financing market and the amounts of leverage banks are willing to offer," says Telly Zachariades, partner at US-based investment bank The Valence Group. "This is fueling private equity capabilities and higher transaction multiples."

Buyers are now able to borrow in excess of three times EBITDA and as much as six times EBITDA for chemical deals, notes the banker. "The amount of equity demanded from private equity firms has gone down to as low as 25%, compared with 40-50% a year ago," Zachariades adds.

"People seem to be more willing to consider sales of businesses - a trend that's been continuing for the past nine months," says Cerimele.

"Debt markets are stronger so private equity firms are able to be more active as buyers of businesses, and strategic buyers still have plenty of cash," he adds.

Chemical companies that have recently sold non-core "orphan" businesses to private equity firms include Netherlands-based LyondellBasell Industries (flavors and fragrances unit to Pinova, a portfolio company of Canada's TorQuest Partners for $150m) and Netherlands-based DSM (DSM Special Products to Emerald Performance Materials, a portfolio company of US-based Sun Capital Partners). On 31 January, US-based Cytec Industries announced the planned sale of its Building Block Chemicals business to the global HIG Capital for $180m.

"We expect 2011 to be another active year for chemical industry M&A and will likely match or exceed 2010 levels - both in terms of number of deals and dollar volume"
Peter Young, President, Young & Partners
"It's sometimes hard to sell a business when it's doing well but Cytec believed the Building Block Chemicals business was so cyclical that it impacted its share price," notes Zachariades, who advised Cytec on the deal.

On the sell side, private equity firms are not being held back by adverse market conditions and so are putting assets on the selling block.

"We are seeing continuing strength in strategic buyer interest so there is a good chance these private equity assets could be sold to strategics," says Cerimele.

On February 2, US-based Momentive Performance Materials, owned by global private equity firm Apollo Management, sold its inks and adhesive resins business to Japan-based resins firm Harima Chemicals for $120m.

TIME TO SELL
"Market conditions are very supportive of being a seller in this environment," says Leland Harrs, managing director of US-based investment bank PrinceRidge Group.

"It's encouraging to see large strategic deals early in the year being announced at strong multiples"
Allan Benton, vice chairman and head of the chemical industry practice, Scott-Macon
"We are highly confident that there will be an unwinding of assets by corporates as well as financial sponsors. On the buy side, chemical companies have the best balance sheets I've seen in my career and are looking to put capital to work," Harrs adds.

More private equity firms are also entering the chemical M&A market on the buy side, notes John McNicholas, co-head of corporate finance at PrinceRidge. "We're seeing sponsors that traditionally have not been strong players in chemicals gearing up to look for opportunities in the sector, particularly mid-level private equity firms," he says.

"Many years ago, it would only be the brave sponsors that ventured into chemical leveraged buyouts, but today you have dozens that would do a deal," says Harrs.

"Traditional fears of chemical-related investing have given way to an understanding of the high returns that are possible, so you have more money chasing deals," he adds.

"They can either go through a complex [Reach] registration process, or buy an asset in Europe that has the expertise that allows them to circumnavigate this"
Constantine Biller, director, chemicals and industrial group, Clearwater Corporate Finance
In some cases, private equity firms have teamed up with former chemical management to pursue deals. US-based New Mountain Capital brought in Raj Gupta, former CEO of US-based specialty chemical company Rohm and Haas, in 2009. It completed its $280m acquisition of US high-purity chemical firm Mallinckrodt Baker in August 2010.

VALUATIONS ON THE RISE
Transaction valuations have moved higher off of 2009 trough levels in both commodity and specialty chemicals - a trend that could pose a challenge to private equity buyers.

"Debt markets are stronger so private equity firms are able to be more active as buyers of businesses, and strategic buyers still have plenty of cash"
Chris Cerimele, director and head of chemicals, Houlihan Lokey
"With public trading values no longer at a discount to the market and higher M&A multiples, financial buyers' share of the market will be reduced compared to strategic buyers," Young says.

As transaction multiples rise, strategic buyers tend to have the advantage over their private equity counterparts as they can achieve more synergies and thus pay the higher price.

Buoyed by the improving financing market, financial buyers accounted for 13 transactions over $25m in size, or 20% of the total number of deals, and 42% of the dollar volume in 2010, according to Young & Partners. That marked a solid rebound from only four deals, representing 15% of the total number in 2009.Global specialty chemical M&A multiples have recovered to pre-financial downturn levels, says Allan Benton, vice chairman and head of the chemical industry practice at US-based investment bank Scott-Macon. The median enterprise value (EV)/EBITDA multiple for specialty chemical deals in 2010 was 9.5 times - up sharply from 7.3 times in 2009 and back near the level of 9.6 times in 2008, according to Scott-Macon. The median EV/EBITDA multiple for specialty chemical deals between 2004 and 2008 was 9.1 times.

"Market conditions are very supportive of being a seller in this environment. We are confident that there will be an unwinding of assets by corporates [and] sponsors"
Leland Harrs, managing director, PrinceRidge Group
Commodity chemical median EV/EBITDA multiples have remained relatively steady, at 6.1 times in 2010; 6.6 times in 2009; and 6.8 times in 2008, according to Scott-Macon. Strong valuations appear likely to continue into 2011, says Benton. "It's encouraging to see large strategic deals early in the year being announced at strong multiples." On February 16, Switzerland-based specialty chemicals firm Clariant announced the acquisition of German adsorbents, catalysts and biofuel technology firm Sud-Chemie for €2.0bn ($2.7bn), or a multiple of 10.5 times 2010 EBITDA.

On January 10, US-based chemical major DuPont agreed to buy Danish food ingredients and enzymes company Danisco for an enterprise value of $6.3bn (including the assumption of $500m in debt), representing a multiple of 12.8 times EBITDA, according to an estimate by J.P. Morgan analyst Jeffrey Zekauskas. However, these double-digit multiples are not the norm. Large strategic deals typically command premiums. Valuations depend asset-to-asset, with a number of deals done in the four to seven times EBITDA range, say sources.

VALUATION DISCONNECT POSSIBLE
However, the overall trend in valuations has been up. And the combination of high valuations and higher raw material costs could provide a headwind for chemical transactions in the months ahead.

"I never thought I'd see this much of a comeback so quickly in the financing market and the amounts of leverage banks are willing to offer"
Telly Zachariades, partner, The Valence Group
"2010 was a pretty good year for most chemical companies as raw material costs were modest and they were able to secure price increases. But now raw material availability is tighter and prices are higher," says Zachariades. "From an M&A perspective, this may cause a disconnect between buyers and sellers as profitability demonstrated in 2010 may not necessarily be sustainable."

Companies aiming to sell businesses based on high 2010 EBITDA levels may face resistance from sellers skeptical of a repeat performance because of margin pressures. However, this depends on where companies are in the supply chain.

While many chemical intermediates producers are exercising tremendous pricing power, "buyers of intermediates, such as paints and coatings companies, are getting hit with these higher costs and being squeezed," says Zachariades.

"If you're a paint company supplying to Home Depot, the consumer end isn't going to support a price increase in today's environment unless you have a strong, differentiated brand."

This valuation disconnect is partly responsible for a number of busted auctions, says Zachariades. "The success rate of the traditional broad-based auction process is not particularly high at the moment."

Factors include a reluctance of buyers to pay high multiples, as well as private equity sellers having the option to refinance and pay themselves a dividend rather than selling outright. The latter factor demonstrates the double-edged sword of a strong financing market.

"If a private equity owner can put more leverage on a business they own, and strategic buyers are wary about the sustainability of EBITDA and are not prepared to pay 'x' times last year's number, the owner may decide to keep it," says Zachariades.

CROSS-BORDER M&A ASIA TARGETS EUROPE
Asian chemical companies are actively looking to acquire European chemical assets - partly to gain compliance with the EU's Reach legislation.

"Players from Asia want certain European chemical assets," says Constantine Biller, director of the chemicals and industrial group at UK-based investment bank Clearwater Corporate Finance.

"The EU's Reach legislation is having a big impact on non-Reach compliant Asian players that need some way of dealing with it - they can either go through a complex registration process or buy an asset in Europe that has the expertise that allows them to circumnavigate this," he adds. Clearwater advised Ireland-based crop protection chemicals company AgriGuard on its sale to Japan-based Mitsui AgriScience International in August 2010 - a transaction where the Reach issue was a prominent feature. Recent deals involving Asian buyers of European chemical assets include China National BlueStar agreeing to acquire most of Norway-based silica products company Elkem for $2bn (€1.5bn), and PetroChina offering $1bn for a 50% stake in Switzerland-headquartered INEOS Refining - part of a broader deal with INEOS that also involves sharing petrochemical production technologies.

"Most of our sell-side activity sees bidders from this geography. They're not winning all of them but they are definitely present," says Biller, whose firm focuses on mid-market deals up to around $500m.

China-based buyers have typically focused on larger assets with more than $800m in revenues, notes the banker.

"But they're starting to come down because a lot of smaller businesses also have the technology they're looking for," says Biller.

 


By: Joseph Chang
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